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1. Exclusion of rent from genuine residential or commercial property from unassociated business taxable earnings

Exclusion of lease from genuine residential or commercial property from unrelated organization taxable income

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Rental earnings from genuine residential or commercial property received by exempt companies is normally left out from unrelated service gross income (UBTI). However, lease might not fall under the exclusion in numerous situations, such as when considerable individual services are provided to lessees, if more than 50% of the rent is for using individual residential or commercial property, if the residential or commercial property is or leased to a regulated entity, or if the organization is exempt under Sections 501( c)( 7 ), 501( c)( 9) or IRC 501( c)( 17 ).

IRC Section and Treas. Regulation

- IRC Section 512( b)( 3) Rents from real residential or commercial property excluded from UBI.
IRC Section 512( b)( 13) Special rules for certain quantities received from regulated entities.
IRC Section 514( b)( 1) Definition of debt-financed residential or commercial property.
Treas. Reg. Section 1.512( b) -1( c) Rent modification

Resources (lawsuit, Chief Counsel Advice, Revenue Rulings, internal resources)

- Ocean Pines Ass 'n v. Comm' r, 135 T.C. 276 (2010) The Tax Court held that profits received by a 501( c)( 4) house owners' association's operation of parking lots was not lease from real residential or commercial property left out from unassociated company gross income by Section 512( b)( 3 ).
Gundersen Med. Found. v. United States, 536 F. Supp. 556 (W.D. Wis. 1982) A medical instructional and research foundation exempt under section 501( c)( 3) leased a few of its buildings, which were subject to a mortgage, to a personal non-exempt center. The court found that the rental earnings from debt-financed residential or commercial property was not unrelated company earnings, under Section 514( b)( 1 )( A)( ii), due to the fact that the clinic's usage of the leased genuine (and personal) residential or commercial property in providing medical services and training medical students was considerably related to the foundation's exempt purposes.
Rev. Rul. 69-69, 1969-1 C.B. 159 The leasing of houses and the operation of a dining hall by an exempt company constitute unrelated trades or businesses where occupying the apartment or condos is not mostly for the benefit of its members.
Rev. Rul. 80-297, 1980-2 C.B. 196, magnifying Rev. Rul. 76-402, 1976-2 C.B. 177, holds that an exempt school that uses its tennis centers for 10 weeks in the summertime as a public tennis club operated by employees of the school's athletic department is engaged in unrelated trade or business and the earnings made is not excludable from unassociated business taxable income as rent from real residential or commercial property. If, nevertheless, the school leases the tennis facilities for a repaired charge to an unassociated person who runs a tennis club for the general public, the school is still engaged in unrelated trade or business, however the lease earnings is excluded from unrelated business taxable earnings as rent from genuine residential or commercial property.
Rev. Rul. 80-298, 1980-2 C.B. 197 holds that income from the lease of a football stadium by a tax-exempt university to a professional football group is not lease from genuine residential or commercial property omitted under Section 512( b)( 3) due to the fact that the university provided considerable services (which did not constitute customary services) for the convenience of the group. 1989-B EO CPE Text PDF - Rents from Real Residential Or Commercial Property - Rendering Services

Analysis

According to IRC Section 512( b)( 3 ), leas from real residential or commercial property are omitted from unrelated business taxable income. Real residential or commercial property is land and any buildings or other structures permanently connected to land, and includes any residential or commercial property explained in IRC Section 1245( a)( 3 )( C). However, there are several circumstances in which the exclusion does not apply. These may include:

Rent, if the leasing of facilities includes the provision of services, such as food and beverage sales. Rental payments for the usage of spaces or area where services are also rendered to the residents does not constitute lease from genuine residential or commercial property. Services are thought about rendered to occupants if they are mainly for their convenience. Those services typically or usually rendered in connection with the rental are ruled out rendered to occupants. See Treas. Reg. Section 1.512( b) -1( c)( 5 ),

For instance, the providing of maid service constitutes service to the resident, whereas the furnishing of heat and light, the cleaning of public areas, and the collection of trash, are ruled out as services rendered to the resident. Rental income from hotel rooms, storage systems, or parking lots is not thought about rent from real residential or commercial property. See Rev. Rul. 69-69, Rev. Rul. 80-287, and Rev. Rul. 80-298. Similarly, in Ocean Pines Association, Inc., the court held that the income gotten from parking area was not rent from real residential or commercial property and for that reason the income was subject to UBIT.

Rent from "net profits" leases. Where the rental earnings is based on a portion of the lessee's sales or profits, the rental income will not receive exclusion. See Treas. Reg. Section 1.512( b) -1( c)( 2 )( iii)( b).

Rent from "blended leases." Rent from a lease where more than 50 percent of the overall rent is attributable to individual residential or commercial property will not be excluded from unassociated company taxable income. Treas. Reg. Section 1.512( b) -1( c)( 2 )( iii)( a). Unrelated income from debt-financed residential or commercial property. Rent from residential or commercial property gotten with acquisition insolvency, as specified in IRC Section 514( c), unless significantly all of the use of the residential or commercial property is substantially associated to exempt functions. IRC Section 514( b). For instance, in Gundersen Med. Found the court concluded that more than 85% of the usage of the debt-financed residential or commercial property was significantly dedicated to the exempt purpose of the Foundation and therefore the rent was not subject to UBIT.

Rent got from a controlled entity. As explained in IRC Section 512( b)( 13 ), rent received from a regulated entity is includable in unassociated business earnings to the extent it decreases the net unrelated income of the controlled entity.

Rents received by companies described in Sections 501( c)( 7 ), 501( c)( 9 ), and 501( c)( 17 ), to which unique UBIT guidelines apply under IRC Section 512( a)( 3 ).

Issue indicators or audit tips

- Did the return show rental earnings and a mortgage?
Tour the centers. Exist signs of locations or structures being leased? Identify which areas or buildings are debt-financed.
Did taxpayer provide paperwork such as a rent/lease agreement revealing the earnings was from real residential or commercial property?
Did the documents such as mortgage arrangement supplied show if the genuine residential or commercial property that the EO got income from is financial obligation financed?
Did taxpayer provide documents such as a service contract revealing whether services were offered the rental income received?